India: 500 and 1000 rupee note demonetisation

At first glance it seems like this might be the idea behind Prime Minister Modi’s announcement that the two largest denominations of Indian currency are to be discontinued – until you learn that they are being replaced with an alternative 500 rupee note and a brand-new 2000 rupee note (twice the value of the 1000 Rs note it supplants).

The stated idea is to clamp down on ‘black money’ (funds derived from tax evasion or the black market) and nefarious activities fuelled by counterfeit currency (for example, terrorism). It’s hoped that those who have stockpiles of large-denomination banknotes will find their ill-gotten gains have suddenly become a worthless burden.

This is why the scheme was formulated and the new money printed in utmost secrecy, as well as why PM Modi’s 8th November live TV address announcing that 86% of India’s cash would soon be defunct was completely unscheduled. But as necessary as these shock and awe tactics might have been to the measure’s success, it also appears to have been instrumental in sparking the chaos that followed.

“The deliberate lack of transparency has confused – and in some cases terrified – the population.”

There has been mass panic and even reports of suicide among individuals who appeared to have fallen under the impression that their savings had been immediately wiped out. Banks became inundated with citizens trying to protect their savings from imploding, queues snaking out into the streets as banks realised they didn’t actually have enough small change or sufficient stores of the new banknotes to execute the huge volume of transactions necessary.

Because it’s not just criminals who have large quantities of money stashed away. Indian small business owners, farmers and even just families in general tend to have significant cash saving, and the Indian government are targeting them too – albeit somewhat surreptitiously.

Although it will still be possible to deposit the old notes into bank accounts up until the end of December, anyone attempting to pay in over 250,000 rupees (£2,962) will find themselves having to prove that they’ve paid tax on the money, and – if unable to – will be required to stump up back taxes and a hefty fine to the tune of 200% of the tax owed.

As much as Modi’s plan is a legitimate and to some extent admirable attempt to recoup untaxed money from the black economy, the deliberate lack of transparency inherent in implementing the measures has confused – and in some cases terrified – a section of the populace who are unlikely to have been savvy enough to circumvent the process anyway.

As is so often the case when it comes to finance, it seems probable that those least au fait with the system will be the ones to be hit hardest, while information that has been deliberately withheld serves only to make the situation all the more bewildering.

James is freemarket’s Chief Commercial Officer. He has a history of finding new ways to solve age-old financial challenges and was responsible for launching some of the first online money transfer and prepaid card initiatives in Europe.